Today we are going to look at Olam International Limited (SGX:O32) to see whether it might be an attractive investment prospect. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
How Do You Calculate Return On Capital Employed?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Olam International:
0.05 = S$703m ÷ (S$25b - S$11b) (Based on the trailing twelve months to June 2019.)
Therefore, Olam International has an ROCE of 5.0%.
Does Olam International Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see Olam International's ROCE is meaningfully below the Consumer Retailing industry average of 8.8%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Olam International stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
Olam International's current ROCE of 5.0% is lower than 3 years ago, when the company reported a 7.1% ROCE. So investors might consider if it has had issues recently. You can see in the image below how Olam International's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. You can check if Olam International has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Olam International's Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.
Olam International has total liabilities of S$11b and total assets of S$25b. As a result, its current liabilities are equal to approximately 44% of its total assets. With a medium level of current liabilities boosting the ROCE a little, Olam International's low ROCE is unappealing.
Our Take On Olam International's ROCE
This company may not be the most attractive investment prospect. You might be able to find a better investment than Olam International. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.